The Greenspan Market

Wall Street Journal ^ | May 13, 2004 | Editorial

[OESY]

The U.S. economy may be zipping along, but the animal spirits in the stock market are looking decidedly bedraggled. Yesterday the Dow was on a roller coaster, falling more than 160 points before recovering for a small gain. The index lost 123 points last Friday and 127 points on Monday, closing below 10,000 for the first time this year. This comes despite rising corporate earnings and productivity, plus another positive jobs report showing that companies hired 288,000 additional workers last month.

Given that the market usually anticipates what the real economy will be doing some months out, this has a lot of people trying to figure out what bad news may lie in store. The standard reasoning is that Wall Street is merely getting used to the idea of Chairman Alan Greenspan and the Federal Reserve raising interest rates. And perhaps that is part of the story.

But it's not a very satisfying explanation because the Fed hardly seems eager to raise rates right away, or very rapidly when it does move. Rather, it is telegraphing a softly, softly approach, cautiously making sure the markets are prepared psychologically. And even when rates do rise, they will remain low by historical standards. At this point there is hardly reason to fear that an overzealous Fed is going to choke off the recovery.

Quite the opposite. Here's an alternative theory: The one thing that markets cannot abide is uncertainty. And at present we have plenty of that, and in multiple varieties.

SNIP

[OESY]

UNSNIP

The revelations of prisoner abuse in Iraq not only represent a setback to the American efforts to stabilize that country, but they may be used by domestic critics of the war to undermine public support for victory. The Presidential election remains a tight race, meaning that economic decision-makers don't know what kind of policies (e.g., tax increases) they will face after next January. Oil at $40 a barrel despite plentiful supplies also increases anxiety.

But perhaps the greatest source of uncertainty is the evidence of renewed inflation and the response of the Federal Reserve. It was astounding that the Federal Open Markets Committee's statement after its meeting last week still referred to the possibility of deflation, stating that "the risks to the goal of price stability have moved into balance." While acknowledging that some recent data show rising prices, "long-term inflation expectations appear to have remained well contained," the central bankers concluded.

It's true that the recent declines in commodity prices including gold have to be counted as good news. These have proven to be reliable leading indicators of brewing inflation in the past. But the recent slackening in demand for raw materials may be due to temporary factors, such as Beijing's efforts to engineer a soft landing for the red-hot Chinese economy, and the subsequent retreat of some speculative buyers.

Meanwhile, the statements of individual Fed governors and presidents also suggest that they aren't in an inflation-fighting mood. Yesterday Chicago Fed President Michael Moskow told CNBC, "The type of inflation increases we've seen this year have been transitory," and predicted a "gradual pace" of rate rises.

The main reason the Fed claims to be so sanguine is that it has its eye on the gap between the economy's productive capacity and its actual output. Mr. Moskow has indicated that this gap is narrowing, and this may provide some justification for tightening. But it should give everyone pause that even as consumer prices have started to rise, the Fed is still fixated on excess capacity on the factory floor rather than on price signals in the real economy.

It's striking how the Fed governors seem to have been surprised by the strength of the present expansion. Even after two brisk quarters of growth last year, and even as the economy was growing at a 4.2% annual rate in the first quarter, the official Fed line was still that the risk of deflation actually outweighed that of inflation, and rates would remain at 46-year lows for a considerable period.

We may well be seeing that such an excessively easy monetary policy can end up having the opposite of the intended reassuring effect on the markets. Investors want to believe that the Fed has the nerve to raise rates, if that's what is required to help forestall any new inflation, even if this is an election year. An early and sharp increase in the Fed funds rates might even be called for as a way to signal its seriousness and reduce uncertainty about when and how much it is going to move.

The consensus now is that this Friday's April inflation report will come in at 0.3% -- a still-brisk annual rate of 3.6% -- compared with March's unexpected 0.5%. But should consumer prices once again surprise on the upside, we'd say the sooner the Fed moves the better.

[Just mythoughts]

"It's striking how the Fed governors seem to have been surprised by the strength of the present expansion. Even after two brisk quarters of growth last year, and even as the economy was growing at a 4.2% annual rate in the first quarter, the official Fed line was still that the risk of deflation actually outweighed that of inflation, and rates would remain at 46-year lows for a considerable period."


This reminds me of when the CIA had no clue the Soviet Union was collapsing. Hillry has been warning of a "Hoover economy", something is up with this bunch.

[lentulusgracchus]

Hillry has been warning of a "Hoover economy"

Does she mean bread lines and soup kitchens?

She'd love that. She'd love to be the New FDR, and take over the economy and throw Limbaugh in Allenwood.

[Just mythoughts]

Hillry has been warning of a "Hoover economy"


"Does she mean bread lines and soup kitchens?"


That is a good question. Hillry has been warning for over a year about a "Hoover economy". Exactly what she has in mind is a good question, especially when people like Soros, and Buffet are doing their best to elect a "democrat".